Will This Multimedia Company's Change in Strategy Spell Success

Anindya is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Adobe Systems (NASDAQ: ADBE) was recently upgraded to “market outperform” from “market underperform” by JMP Securities with a price target of $42. The company started transitioning from packaged software to cloud-based “software as a service” last year after sequential declines in earnings and revenue. I expect Adobe’s transition should boost its share price over the medium to long term.

Fiscal Q4 Results Have Been Impressive

Adobe’s financial results for the fiscal fourth quarter have been relatively stronger than analysts’s estimates. Revenue was flat compared to the year-ago period, but up about 7% on a sequential basis. The company's digital media business saw a 2% year-on-year decline, while revenue increased 5% sequentially. In digital marketing, revenue rose 5% from last year and 10% from the prior quarter. Adobe reported earnings of 44 cents per share, or $222.3 million, a 28% increase from the 35 cents per share, or $173.7 million, it posted a year earlier.

Adobe attributed its robust earnings to strong growth in subscriptions for its creative services, which added an average of 10,000 new subscribers weekly during the quarter -- 25% faster growth than the third quarter.

Transitioning to the New Business Model

The transition to the new business model caused Adobe to take a $94 million restructuring charge in the fourth quarter last year. With the new business model -- which delivers software over the Internet and keeps customers instantly up to date via the Internet -- the company is presenting more pricing options and flexibility to casual and professional users.

In the new business model the company is basically focused on two large market opportunities, which are Digital Media and Digital Marketing.

Digital Media: In the Digital Media business, the company is redefining the creative process with Creative Cloud. Through frequent product and feature enhancements, new cloud services and attractive pricing, Adobe is providing value to a broader set of customers. In this way the company is delivering customized offerings for individuals, work-groups and large enterprises.

Digital Marketing: Using its new cloud-based platform, Adobe is also diversifying into digital marketing, offering services like data mining to help businesses measure page views, purchases etc.

“There’s no question that we’re seeing quite a bit of synergy between the Creative Cloud and the Marketing Cloud”, Adobe’s CEO Shantanu Narayen claims. The customers of one segment become more likely to purchase products from the other one, accelerating Adobe’s revenue growth in both simultaneously.

Why the Transition Was Necessary

The transition was an effort to capitalize on Adobe’s existing competitive advantage in the traditional digital media business. According to a research report by Deloitte, most of the future growth in this sector will come from new digital media, better known as born interactive media. 

With projections of better than 6% growth over the next five years, it is widely believed that the digital media sector is expected to continue with the success it has enjoyed over the past decade. Consensus forecasts suggest that most of the growth will come from new digital media that was designed from inception to be interactive (born interactive). This new media will be delivered through internet and mobile platforms, unlike traditional media which, according to forecasts, will continue to confront a shrinking market. 

You can read the full story here.

Adobe's Challenges

Adobe’s transition efforts will not resolve the company's challenges in driving more users for Flash and making it a go-to standard for the Internet against offerings from rivals like Microsoft (NASDAQ: MSFT) and Oracle (NYSE: ORCL).

Adobe Flash Player plugin has never been supported by Apple (NASDAQ: AAPL) and Adobe has finally discontinued their attempts to get Flash to work properly on mobile devices in general. Many websites that use Flash on Mac or Windows PC offer the exact same video in HTML5/H.264 format for Apple’s iPad or iPhone. YouTube.com is the biggest example.

Some websites like Netflix.com use Microsoft Silverlight, which is a development platform by Microsoft for creating rich media applications for the Web, desktop, and mobile devices. It’s a free plugin powered by the .NET framework that is compatible across multiple browsers, devices and operating systems.

Some sites have chosen to offer apps instead of converting their videos to HTML5/H.264 format on the web. A lot of popular Flash games have versions of the same game in apps. These apps are created using Java, a technology from Oracle, formerly Sun Microsystems. Microsoft’s .NET technology is also widely used in developing such apps.

Failing to make Flash the go-to standard for the Internet for playing rich media applications could result in substantial revenue loss for Adobe. 

Conclusion

Adobe’s transition to the new business model will only sustain in the long run if the company becomes able to build a loyal subscriber base, with a strong retention rate. It seems the company is progressing in the right direction by offering different value-added services using its cloud-based platform.


Anindya7 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Microsoft, and Oracle. Motley Fool newsletter services recommend Apple, Adobe Systems, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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